Posts Tagged ‘Shanghai Stock Exchange’

Is the real reason behind the Shanghai rout due to something else?

Wednesday, February 28th, 2007

Last night, the Shanghai casino (stock market) fell in a stampede of panic, triggering a worldwide sell-off. For us, we are not the least surprised to see that. In fact, as we advised back in January this year in Discerning a stock market bubble, that was the time to exit the Chinese stock market. Coincidentally, within less than a week after our warning, it corrected. Yesterday was the second major correction within a month.

Now that the dust had settled, we are wondering why did a Chinese sell-off create such a ripple effect to the rest of the world?s stock market. The previous correction of 4.92% at the end of January was hardly news at all. Surely, the magnitude of yesterday?s correction, though greater than the previous one, should not be the reason for such a contagion?

The ?official? reason for this market correction was that a rumour of the Chinese government?s intention to crackdown on speculation triggered the sell-off in Shanghai. While this reason may be true in the general sense, we guess nobody knows the real underlying reason. Here, we offer our speculative hunch (which require more investigation to confirm)?this may have something to do with the yen carry trade. Back in January, in Liquidity?Global Markets Face `Severe Correction,? Faber Says, we mentioned about Marc Faber?s prediction about a coming severe correction in all assets class in the coming months. Though he did not fully explain the underlying reason behind this prediction, he did mention about the idea of liquidity (see Liquidity?Global Markets Face `Severe Correction,? Faber Says on the concept of liquidity). Thus, we believe that when he made that prediction, he saw a coming liquidity crunch in the days ahead. Back in Liquidity?Global Markets Face `Severe Correction,? Faber Says, we did ask this thought provoking question: Are we now ripe for a contraction in liquidity?

A week ago, in Another source of potential financial crisis?reversal of yen carry trade, we did mention about the ramifications of a potential disorderly reversal of the yen carry trade. Much of the world?s liquidity can find its source in Japan through its near zero interest rate policy. However, it is obvious that the Japanese will normalise their interest rates sooner or later, which means the yen carry trade will have to end one day. The question is, whether this end comes through an orderly or a disorderly process. A disorderly process means that non-Japanese assets will have to be quickly liquidated and yen re-purchased to pay back the yen-denominated credit. This will result in a rapidly falling non-Japanese asset prices and a swiftly appreciating yen. Recently, Japan had raised its interest rates to 0.5%. Also, Japanese inflation is picking up and their stock market is trending up. The indications point towards the Japanese tightening up their liquidity. Perhaps someone reversing their yen carry trade on frothy Chinese stocks started the Shanghai rout?

Anyway, this is just our hunch?we are prepared to be proven wrong on this. But if our hunch is right, this means that there will be more corrections to come. That may explain the severe reaction of the global stock market.

Caution: new high in Shanghai Stock Exchange Composite Index

Saturday, December 30th, 2006

Today, we just looked at the chart of the Shanghai Stock Exchange (SSE) composite index and found that it had hit a new high on the last trading day of 2006:

Shanghai Stock Exchange Composite Index- last trading day of 2006

With the vast pool of foreign money pouring into China (see Why is China printing so much money? and Speculative fervour in the Chinese stock market), this is expected.

An example of such foreign money joining in the wild party of raging liquidity in the Chinese stock market is the AMP China Growth Fund. That fund listed on the Australian Stock Exchange (ASX code: AGF) on the 22nd Dec 2006. Within 4 short trading days, the price of AGF surged 20% upwards to $1.20 from its issue price of $1.00. Should we sink our money into AGF? Let?s take a look at its 4 days of trading history?on its first trading day, the volume of trade for that stock was 5.3 million. On the second day, it was down by half to 2.7 million. On the third and fourth day, it was down to 1.8 million and 1.4 million respectively. What do you see? As the stock price surged upward, the quantity of volume traded declined significantly. It looks to us that the upward momentum for the stock is weakening.

Next, we look at the above-mentioned chart for the SSE. Looking at the technical indicators, we see that the upward momentum is very strong?in fact, too strong for our comfort. Also, the chart is becoming parabolic in shape, almost becoming a vertical line at the end. And here is a number one basic rule of trading: when the chart becomes parabolic to the point of becoming a straight line, it is a classic sign of a bubble about to burst. If you are holding that stock, get out as soon as you can. That is what happened to the gold price in May 2006 before the correctional crash. If you look at the 10-year chart for gold, you will see a parabolically vertical line around that time:

10-year gold chart on final trading day of 2006

Again, we would like to stress that we are not trying to predict an imminent crash in the SSE (and a corresponding crash in the AGF). We are urging the exercise of caution?the party cannot last forever. As with most bubbles, the collapse in price is usually more rapid than its rise.